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Issue 1 November,2014

CaPItal FloWsINto INdIa

a look into the big pictureof capital flows in India

trends and outlook

Easy, safe and secure taxBenefits

INvEstmENt INgold EtF

E-CommErCEIN INdIa

FslrC the overhaul of Indianfinancial lanscape

efinancialConnect

A lOOk AT AlTErNATivE mONEymArkET iNsTrumENTCBlO

eFiNANCiAl

efinancialConnectcontents

IssUE 1 | NovEmBEr 2014

Check out the Trends and Outlook ofEcommerce in India PAGE 24

Know the Inside out of Capitalflows in India PAGE 22

Framing the future of RiskManagement PAGE 03

An Interview with Lakshmi GangatkarAdministrative Director PAGE 27

From thE EdItor

a message from the CEo of

efinancialconnect.com

rIsK govErNaNCE

Framing the future of risk management

strUCtUrEd FINaNCE

structural and Collateral analysis

CBlo

a look at alternative money market

instrument

FslrC

the overhaul of Indian Financial landscape

maKINg sENsE oF P/E ratIo

Plotting P / Bv ratio with roE

INvEstmENt IN gold EtF

Ease, safe and secure tax Benefits

CaPItal FloWs IN INdIa

a look into the big picture of captial

flows in India

E-CommErCE IN INdIa

trend and outlook

QUICK BItEs

lakshmi gangatkar

administrative director, tIEI

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030710

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EfinancialconnEct

EfinancialconnEctfrom thE Editor

Dear Readers, It gives me immense pride as the Founder of efinan-cialconnect.com (EFC) to introduce you to the inaugural issue of its monthly newsletter. Efinancialconnect.com is a pioneer within the profes-sional networking space for finance professionals. The mis-sion of EFC is to provide 3 way communication links between Industry leaders, academic experts and budding aspirational students. My vision for this newsletter it that it will play a role of a mentor in providing necessary guidance and encourage-ment to foster professional growth and individual development within both corporate and academic space. In an attempt to pen the mission of efinancialconnect.com in words, my eastern ethos races to our finest and most insightful classics of world literature – Bhagwad Gita. Inspite of being the oldest surviving culture in the world, its wisdom and practicality of its content are relevant now more than ever. Lord Krishna, Arjuna’s Charioteer, was his greatest asset, friend, philosopher and guide. Without being directly involved, Krishna encouraged Arjuna and gave him the strength to fight. An ideal mentor serves the same purpose in the organizational context. Efinancialconnect.com newsletter is being sculpted to provide this mentorship with an ultimate goal of knowledge sharing. I would also like to thank the entire team of efinan-cialconnect.com for their commitment and sincere efforts for bringing out this first issue. I hope you like this issue of EFC. Your appreciation, comments, feedback would be much appreciated.

Thank you Yours sincerely

SANKET ANIL JOSHI – Founder and CEO of efinancialconnect.com

Connecting Professionals Worldwide

EdItorsanket Joshi

sUB EdItoraayush Jain

CoNtrIBUtorsaayush Jain, Chitrank Jaindhawal dave, divya roongta Jyoti tanwar, Nishant Poojary ramya lakshminarayanansanjay Kadam, sufiyan sarguroh

marKEtINg hEad Noopur shah

dEsIgNErJinali Parikh

We would like to hear from you Email: efinancialconnect@gmail.com

Efinancial Connect is monthly magazine published by Efinancialconnect.com

Efc page 03

RIsK GovERnAnCE Framing the Future of Risk Management

reuters

The world awoke to formal risks management after

the collapse of Bank Haus Herstatt. The regulatory world gifted us the Basel Ac-cords. However, in the past five years or so, we have seen a subtle shift in the concept of risk management. Five years ago, when we spoke about risk it was predomi-nantly treasury risk – deal capture and position keep-ing at the most – not the sys-tems we know today. Banks and corporates evolved from positions keeping and mark to market which they con-sidered risk management to the value at Risk and Stress Testing frameworks in the Mid Office, to testing the portfolio for shocks and performing scenario analy-sis. Most banks have gone through at least two rounds of risk management system implementation.

The current thinking is integrated risk management, which, apart from the front, mid and back office also in-

cludes getting a direct exter-nal data feed to help them value their portfolios – more so as a double check as to whether they are doing the right thing from a trading per-spective. Today we are talk-ing about having a system that will integrate all the bits and pieces of risk manage-ment software we have into an integrated framework so that we can identify, measure and monitor the risks across the organization. However, when we look at risk from the board per-spective, one of the critical components is the risk gov-ernance framework. Without the governance framework, the multiple pieces of soft-ware may not yield optimum results. We are seeing the emergence of oversight of the output of these risk sys-tems. Two major stakehold-ers emerge – the risk man-agement committee which reports to the board and the internal audit team. The gov-ernance is manifested by the

the past decade or so has seen a rising tide of distress among the finan-cial services sector. the 2008 crisis turned the spotlight on to an important facet of risk management –the risk governance framework. the financial institutions that failed in the US had the mandated risk man-agement tools in place. Yet they failed. What went wrong? the firms neglected the most important element of risk management – the risk governance frame-work. mr. Sriram ramnarayan, country head finan-cial and risk, thomson reuters, reasons why we need to focus on gover-nance frameworks.

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Efc page 04

independence of the people who are per-forming that job. The benefit we have to-day is the electronic help we can provide these teams. This will tie in well with the board reporting – where either we will have an on systems clear signal, or the potential losses hidden in the numbers. An important ingredient here is to equip the members of the board – including the independent directors – with knowl-edge about both the internal workings of the firm and also the industry level devel-opments – for example what are banks across the world doing about the Basel III regulations, or the impact of Liquidity Coverage Ratio on the banks Asset Li-ability Management. We need to remember that most of our banks and large corporate customers are now trans- national. The members of the board of directors need to be aware of developments across the globe. Any-thing undesirable happening in any of these units outside India will have a direct repercussion on their Indian operations. Banks and corporate houses have placed the importance of direct control, observa-tion and remedy within an independent set of either a board committee on risk or audit, who have no direct connection with the operations.

The intent has to start from the top, the execution will be at the bottom and the adherence to the principles laid down by the board committee has to be in the middle. This is not without its challenges. The biggest challenge is that all the parts of a good governance and compliance framework are disjointed and act as silos

within the enterprise. The effort it takes to stich up all these disparate elements is a heavy task. Questions like ”who should the head of internal audit report to?“ or ”Who should the CRo report to?“ need to be addressed. Why should the head of internal audit report to the CFo? How will she maintain her independence? I see two types of challenges – one is the lack of organizational connect and the sec-ond is how do we make sense out of a disparate set of systems that have been accumulated over a period of time as the organization evolves. It is naïve to believe that we can replace the entire set by an integrated, gen next system. The users have grown familiar to the idiosyncrasies of the solution that replacing it will be dif-ficult. That is a technology challenge firms are facing. The question we need to ask is how can I connect the dots seamlessly and with integrity keeping the indepen-dence intact. We have a few good things going – the members of the board are convinced about the need to keep a governance framework, there is unanimous agree-ment. From a necessity, again there is unanimity. But when it comes to imple-mentation, there is an issue. Across the spectrum, we find that all top manage-ment personnel agree on the necessity of a framework. Most of them will vouch for the existence of such a framework in their organization. The strength of the frame-work is yet to be tested by a knock from the outside. How strong is the framework in comparison to their peers in the indus-try – we do not know. We are not sure of the flow through which the framework

Efc page 05

in comparison to their peers in the indus-try – we do not know. We are not sure of the flow through which the framework can percolate down to the last man in the chain. Remember, risk originates from the person doing the transaction – I firmly be-lieve that risk management lies in the per-son in the organization who is doing the transaction with the customer at any point in time. That person is aware of the risk that the transaction poses to the organiza-tion in the short and medium term. The ef-fort should be to translate that knowledge into a framework, a step by step process of the board risk philosophy into action-able system components. There is an understanding and a need. The biggest challenge is to bridge the gap between the front office and the board approved framework. Risk culture should permeate across the organization – it cannot be the preserve of the CFo or CRo, an internal audit team or a risk team. How many of the front line staff know about Basel III or vaR – it has been shipped out to someone out there who will manage it – not the people directly involved with it! smart business houses have taken that up – imbibing the culture of knowing the risk and taking a collective decision from a business perspective. A risk management culture will ensure that the firm has a day to day risk manage-ment perspective embedded along with their ability to do business. There can be two approaches to risk management – one is to drive it like a sledge hammer - so hard that everyone will acknowledge its presence, but none

will survive. The other is develop the abil-ity to take measured and informed risks. The 2008 crisis demonstrated this amply – someone knew about the risks – but as an organization, they probably were not aware of what these risks could do to them. There is a significant shift that we can see – people are no longer inter-ested in seeing if the water is flowing in the right direction –somebody else should do that with the help of technology. The management is interested in thinking dif-ferently about the transactions that are flowing through the system and gauging their impact. We need to realize that inter-nal audit is just a part of the broader risk framework. Technology can help firms move away from the mundane monitoring of transactions to looking at it from a busi-ness perspective. A true risk management perspective does not lie in the control and stoppage perspective, but in identifying bottlenecks and smoothening them out to enable the firm to pursue business goals. This means we need to collect information at a very granular level. In India, we either do not capture all the required information or capture them, but store it in a difficult to retrieve format. We need to do this in real time, concurrent with the business trans-actions. We need to develop the ability to view risk management as a facilitator. It is not the investments in risk management systems that count, it is what you make of it.

We need to develop a culture of looking at risk as an enabler and as complementary to business growth.Across the world, business managers are

Efc page 06

coming round to the view that it is better to invest in technology, people and process-es rather than risk getting caught on the wrong leg. Increasing number of CEo’s are today worried about reputation risk – the risk of getting noticed for all the wrong reasons, rather than the fines it will entail. CEo’s worry about how they can create this cultural shift in risk management, and bring each individual on to a risk frame-work. About how to open the employees

eyes to the salience of risk management in real time. The 2008 crisis has pushed risk governance frameworks on to board room agenda – an ability to define the risk phi-losophy of the organization and ensure that it percolates down to the foot soldier, so that all transactions happen within the board approved framework and informa-tion flow is smooth.

November 2014efiNaNcialcoNNect.com

Efc page 07

STRUCTUREDFInAnCE

authoraayush Jain

securitization is practice of pooling cash flows

from assets/contracts/debts, repackaging them into inter-est bearing instruments and passing the cash flows to the investors of these instru-ments. These securities can have several types of assets back-ing their cash flows, like Residential Mortgages, Auto Loans, Credit Card Loans, stu-dent Loans, Commercial mor tgages, etc. off balance sheet trans-actions of these securitized products can help compa-nies create leverage and help bring their capital re-quirement mandates down.While analyzing a RMBs deal and before any invest-ment decision is taking, there are various deal characteris-tics which are take into ac-count. We should assess the cash flow structure of the is-suance/deal to understand the structural features of the

transition, the loss distribu-tions, various default risks, counterparty default risks and most importantly the col-lateral performance.

Structural and Collateral Analysis

structural analy-sis is first step

in any deal analysis and i n c l u d e s transaction specific fea-tures analy-sis, such as t r a n c h i n g ,

subordination, triggers, etc. In this step the cash flow models are pre-pared to map and asses the deal characteristics, cash flow waterfall, hierarchy of payments, subordination, credit protection, etc. Cash flow modeling helps in de-termining the average life of the deal and sensitivity to various events like prepay-ments, defaults, basis risk, etc. Basic assets and liabil-ity of the deal is modeled to understand the cash flow

hello everyone. Welcome to the first issue of efinancialconnect and my first column in the magazine. in this col-umn i would be writing primarily on structured finance and various secu-ritized products. the articles would be around latest happenings in the structured finance space, technical concepts related to securitization structures and market update. in this edition, i would be taking you through various risks that should be analyzed before taking a position on a structured product security.

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Efc page 08

waterfall and portfolio loss scenarios.

Few collateral characteristics and param-eters which traders look at while making investment decisions are-1. Deal LTV (Loan to value): This pa-rameter shows the leverage of the deal. It shows much loan is advanced to the as-set owner as a percentage of the asset value as on a particular date. More the LTV, riskier the deal is considered. Some deals have also seen a more than 100% LTV!2. Constant Default Rates (CDR): This parameter shows the annualized rate of defaults happening on the under-lying collateral. More the defaults, more the spread on which the tranche would be trading as the riskiness of the deal in-creases. Please note that the legal con-ditions in which a asset owner would be considered to be “default” is very specific to the deal/geography and should be giv-en attention to. 3. Conditional Prepayment Rate (CPR): The characteristic shows the rate at which the borrowers are prepaying the principal and interest due to them. Deal having high CPR numbers might repre-sent that the borrowers are in good fi-nancial state and thus are able to prepay

their loans. This also means that there is a reinvestment risk on the prepaid amount and thus this might increase the riskiness of the entire trade.4. Recovery Rate: What happens when a asset owner defaults? Can the asset be foreclosed? How much per-centage of the original loan provided can be recovered from the foreclosure of the assets? This parameter helps us answer all these questions. It shows how much % of Loan advanced can

be recovered at the time of asset foreclo-sure. A low recovery rate possesses addi-tional risk to investors and deal might not get enough cash flows even after selling the assets to maintain the waterfall.5. Interest Rate hedges and Swaps: What if the assetowners are paying the deal originators in USD and the deal is issued in EUR? What happens when the asset owners pay 3Month Libor and the issuer pays the note holders a 6Month Li-bor? How the Currency, Interest and Ba-sis risk hedged is an important question that traders look out for as these govern how immune the deal would be to these risks.

Counterparty Risk Analysis The key elements in counterparty risk analysis revolve around Risk of de-fault by the counterparty, swap counter-party risk, operational counterparty risk and Legal/Government risk.1. Counterparty Risk: Risk of default by the counterparty is a risk of the coun-terparty in the trade defaulting on their dues to the note holders. The traders more than often are ready to pay a pre-mium on the trade if the counterparty has

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Efc page 09

a good credit rating and has less risk of defaults.2. Swap Risk: As we discussed ear-lier, swaps are very important structural feature in any structured finance deal. In depth analysis is done by the traders on various swap characteristics like the swap counterparty credit worthiness, size of the swaps, tenor of the swaps, DV01 of the swaps etc. These analyses help them to price the tranche as an appropriate spread and determine the risk adjusted price for the notes.3. Operational Counterparty Risk: There are various agents/parties involved in the entire structure of the deal, like the servicer, cash manager, and trustee. The credit worthiness of all of them is very im-portant for the overall risk profile of the transaction and thus is also analyzed by the traders.4. Legal Risk: Certain clauses in the deal structuring like bankruptcy remote-ness can create legal risk in the case of defaults/bankruptcy of the sPv. some countries don’t allow foreclosure of hous-es and sPv can’t sell the assets to raise money to pay the bond holders. All these are part of legal risk which is very closely analyzed before entering into a particular deal.

Other Factors

some other factors that should be looked into the deal before taking a plunge are how the deal is performing historically. Historical performance (Historical CDR, CPR, and severity) is a key indicator how to riskiness of cash flows to the investors are likely to payout to investors in future.

Geographical concentration of assets is a macroeconomic factor which can play a very significant role in the deal perfor-mance. What if you have a significant ex-posure to assets in a particular country and there is a sudden political instability or a natural calamity there and because of which the currency depreciates and as-set prices collapse? Borrower concentra-tion, industry concentration is few more factors which are considered before an investment decision is finalized. More the diversification, less the risk, better it is.one of the most important factors that traders look into a deal is credit enhance-ment and the subordination/seniority of the tranche or issuance. Credit Enhance-ment shows how much cushion is pro-vided to the tranche in case of defaults hitting the trade. And seniority shows till what point the tranche is immune from defaults hitting it. These two parameters define the credit riskiness of investment in the note issuance and should be looking into deeply.

All the above mentioned points are thoroughly analyzed by the traders and then an appropriate spread is determined on which they price the security and are willing to buy/sell the notes.

About the Author Aayush Jain is a Finance professional with experi-ence in pricing various Structured Fixed Income in-struments and Securitized assets. Aayush has ex-perience in valuing and analyzing various Structured Products (including ABS, CMBS, MBS, RMBS, Sov-ereign Bonds and CLOs). Aayush is also passionate about equity trading, tracking market movements and taking positions based on fundamental research.

November 2014efiNaNcialcoNNect.com

Efc page 10

authorJyoti tanwar

CBLo (Collateralized Borrowing and Lend-

ing obligation) is a money market instrument whose Introduction was announced in year 2002-03 by RBI and launched by Clearing Cor-poration of India Limited (CCIL). similar to REPo, an organization with surplus funds can lend out its money in the market to other organi-zations in need of funds with collateral in place. As we know that call money markets where cash for less than a year tenure is borrowed and lent with-out any collateral is open to banks and Primary Deal-ers (PDs) only. Hence there was a need for similar kind of money market instrument that will cater to the needs of mutual funds, big corpora-tions, Provident funds (PFs) etc. The only difference is that CBLo involves collat-eral. Interested parties are required to open Constituent sGL (CsGL) Account with

CCIL for depositing securi-ties as collateral.

Key features of CBLO

1. It is tradable. Hence one can reverse the borrowing/lending position and repay before the term expires.2. CBLO works on principle of novation. i.e. CCIL acts as counterparty to the transac-tion.3. screen based trading provides transparency and maintains anonymity of counter parties.

now let’s look at the different types of CBLoThere are basically two types of CBLo1. CBLo normal market2. CBLO Auction market

CBLo normal mar-ket facilitates borrowing and lending by members on an online basis. The minimum and multiple lot size for CBLo normal market is Rs.5 lakhs.

a BE in Electronics from fr. crcE, mumbai University, currently pursuing mBa in finance from lala lajpatrai institute of management. have around 2.5 years of experience as Sr.Software engineer in iGatE com-puter system, as a software engineer was responsible for Quality analysis.

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authorSanjay Kadam

Pursuing mBa-finance from Univ. of mumbaiholds mS Quantitative fi-nance from Ucd Smurfit Business School, dublin irelandB.E. mechanical from Univ. of mumbaiPassed cfa l1 (USa)nSE certified market Pro-fessional (ncmP) level 3

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CBLo A look at an alternative money market instrument

Efc page 11

CBLo Auction market facilitates borrow-ing and lending by members through sub-mission of bids and offers in the system and its acceptance and announcement of cut off by Clearcorp.The minimum lot size for CBLO Auction market is Rs.50 lakhs and multiple lot size is Rs.5 lakhs.

Room for arbitrage

The arbitrage is available only to banks because they are the only entities that can participate in the CBLo market, the inter-bank money market and in the reverse repo with RBI.The interest rates fluctuate as per market movements; de-mand and supply but it was observed that the interest rates sometimes go far below the repo rates. Let us take an example be-low to show how arbitrage can take place in this market. FYQ2 2009 Rev. Repo rates were at 3.25% whereas CBLO rates were hov-ering in the range of 2.5-3.25%. Hence banks with excess sLR use to borrow in CBLO market at 2.5-3% and lend the same to RBI at 3.25(the then prevailing Rev. Repo rate). RBI has dictated the spread between Repo and Reverse repo at 1pc. Currently (as on 27th Jun 2014) Repo and Reverse Repo stands at 8% and 7% respectively.Hence the moment CBLO rates shifts above 8%, let’s say 8.10% then Banks would borrow at 8% (Repo Rate) from RBI and lend the same at 8.10% in CBLO market. In the same manner if CBLo rates fall below 7% let’s say 6.8% then banks would borrow from CBLO market at 6.8% and lend the same to RBI at 7 %( Rev. Repo Rate).Thus CBLO rates will tend to

be in the range between Repo and Rev. Repo rate of RBI, if not will lead to arbi-trage. If CBLo exceeds/recedes RBI’s Repo /Rev. Repo then LAF volume may rise significantly. RBI is aware of the arbitrage in the money market hence to curb arbitrage opportunity has asked banks to make up CRR funds for borrowing in CBLO.The current CBLO LTR (as on 27th Jun 2014) is 9.11%.

A look at the technicalities CBLO at BPCL:

Bharat Petroleum Corporation Lim-ited is an Indian state-controlled oil and gas company headquartered in Mumbai, Maharashtra. BPCL has been ranked 229th in the Fortune Global 500 rank-ings of the world’s biggest corporations for the year 2013 with an annual turnover exceeding $38.50 billion. As per annual report total revenues for (2012-13) stood at INR 241,795.98 cr. and expense over 90% of revenues towards crude pay-ments and financing costs. now for BPCL which sells most of its crude produce at regulatory prices (be-low market price) needs to fund its work-ing capital requirements on a daily basis. The fund management unit at BPCL’s cor-porate treasury forecasts daily payments and collections on daily, weekly, monthly and quarterly basis. on daily basis the forecasts and actuals creates a surplus or deficit of funds. When in surplus invest-ments are made in money market funds however most of the time there’s deficit and the BPCL borrows in the short term. As seen earlier CBLo is a

Efc page 12

money market instrument for lending/ borrowing money for short tenure, it is the preferred instrument for short term bor-rowing at BPCL during days of normal liquidity in the market. It is evident with the fact that as per Annual report 2012-13 the CBLo through CCIL amounted to InR 622 cr, while Commercial Paper (CP) at INR 430 cr. The time period for CBLO transac-tions is restricted to 1 to 3 days. The max-imum limit imposed by CCIL on BPCL for CBLO borrowing/lending is 1500 crores (per day limit). This is based on the secu-rities pledged and the creditworthiness of the undertaking. It is preferred to take CBLo borrow-ings as compared to all other sources as the CBLo borrowings are the cheapest of all and the rate of borrowing fluctuates as per market movements. 1-CBLo, live, 9 to 2:30 starts off with a high (general-ly) flattens in between and end at a high (general trend), lenders bid and compa-nies post their offer. The counterparty is not known. Generally mutual funds, insurance com-panies pool in their money in the CBLo market, they are the suppliers of fund and companies may borrow them as per their need. Banks are not allowed to be a part of CCIL. offers maybe by various pro-spective buyers which may or may not be accepted. When RBI decides to cut the CRR rate there will be surplus on the sup-ply side. Thus this works like the demand and supply in economics. Offers of Rs 200 crores can be made at a time and maximum limit on the borrowing is fixed at Rs 1500 crores. The limit is fixed on the basis of the collaterals

and the valuation of the company.CBLo interest rates fluctuate as per the demand and supply factors. There is bid interest (%) and bid yield (Rs. crores), these signi-fy the seller’s side. This means the seller is bidding X.X% for XX amount. on the other side there is offer inter-est (%) and offer yield (Rs. crores). This is the offer quoted by the buyers.The order is executed if the offer matches with the bid or if the offer made is higher or equal to the bid interest rate. It is not preferable to offer lower amounts as it increases the transaction cost. For example- offers ranging below 100 crores are generally not made. The transaction cost is Rs 1500 for every offer upto 200 crores. So each time you borrow 200 crores you have to pay 200 crores. Even if you borrow less than 200 crores you have to pay Rs 1500. Choose offer from the options given-offer and bid, type the amount (cr), DQ- optional to skip, MF- refers to the mini-mum order, AON(%)- rate at which order is placed. Thus offers can be made as per the limits and kept outstanding. When the fluctuations in the market reach the rate desired by you, the offer will be executed. The offer may also be modified by selecting the particular option and click-ing on the cell ”modify“ before the order is executed. Thus a close watch needs to be kept at the market. CBLo borrowings are made for short periods, ranging between 1-6 days. The rate offered will be higher if the dealer is borrowing it for 2 days from 2 day than if borrowed for one day. CBLo loans for one day are repaid directly the next day from the bank a/c of the corporate.

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Efc page 13

In the case of BPCL its sBI,The offer is accepted based on 2 factors- • The rate closest to the bid rate is preferred• The order (ascending), offer made first at a given rate will be executed first, when the rates fall to that specific interest rate There is generally a difference of 5-6 bps. The dealer may know if he has made a profit or loss by comparing the weighted average (WA) of the deals executed by him with the weighted average appearing on the CBLo screen (which keeps getting updated with market changes). Till the time the WA of the dealer is lower than the market WA the dealer makes profits.If you have borrowed more than your ac-

tual need i.e when there are some unex-pected receipts report. From 2:30 to 3:30 the CBLO mar-ket is open for banks, but there are hardly any volumes. 90-95% of the volumes are covered upto 2:30. In the past Bharat Petroleum Cor-poration Limited (BPCL) has won Deriva-tives House of the Year, Asia – Corporate award for its committed, effective and prudent hedging activity in 2012. However, BPCL maintains that they only take up positions only to ensure coverage of operating costs and follows a strict policy regarding the expiration of contracts. Hence, in conditions of arbi-trage opportunities they don’t look to prof-it from it.

November 2014efiNaNcialcoNNect.com

one can know the trend by clicking on ”Market Trades”; it shows the trades ex-ecuted in the market.Market by Yield i.e MBY gives the cumulative of the supply and the demand in the market.Market by Offer i.e MBo gives the information on the individual bids and offersWeighted average (%) i.e. WALTY(%)-shows the rate at which the most recent deal was executedLTA (crores)-shows the last executed volumeTTA (crores)- shows the total volume of deals executed in the market upto a par-ticular time

Efc page 14

FsLRC Recommending the overhaul of Indian Financial Landscape

authordivya roongta

Financial sector Legisla-tive Reforms Commis-

sion (FsLRC), chaired by Justice (Retired) B.N. Sri-krishna, is a proposal by the Indian Government – Minis-try of Finance with the first version drafted on March, 2011.This Commission aims to structure the financial sec-tor by reforming the gover-nance and legislation gov-erning it. The Commission was built with a view to mod-ernize the controls over the Indian financial sector which are currently governed by the foundations laid about a century ago, and some of them are outdated and may not be applicable in the con-temporary scenario. The arguments in the favour of the need of a for-malized legal financial frame-work, in addition to the cur-rent regulatory framework, were substantiated by draft-ing the crux of the FsLRC re-port in the form of nine com-ponents which are discussed below:

i. Consumer Protection: To achieve a goal of finan-cial inclusion, the primary step would be to enhance consumer protection, ac-cording to the Commission. It emphasizes on the need of an extension of the onus from the buyers in the form of prevention (stated as Ca-veat Emptor – Let the Buy-ers Beware) to the financial system/service providers/regulators in the form of cure (redress of grievances) ii. Micro-prudential regu-lation: To enable the financial firms to fulfil the obligations and promises made to the consumers, the Commission insists on the intervention of the regulators in the firm’s behaviour to improve the safety and soundness of the firm. The intervention won’t eliminate but would definitely minimize the probability of firm’s collapsing.

iii. Resolution: Micro-prudential regulation would

divya roongta, SimSrEE: loves to uncomplicate the complicated and enjoys dancing and painting. Planning to pursue cfa level 2.

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authornishant Poojary

nishant Poojary, SimSrEE: a fin enthusiast, planning to pursue cfa level 2. an avid reader and enjoys writing.

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Efc page 15

reduce failures; however elimination of failure is not possible or desirable. ‘Resolution mechanism’, suggested by the Commission would avoid dis-ruptive and sudden firm failures. Cur-rently, India has DIGC, Deposit Insur-ance Corporation which is confined to the banks and gives a limited insulation. Consumer protection, micro-pru-dential regulation and resolution will have to work in tandem to enhance the resil-ience and capability of the financial sys-tem as a whole by ensuring consumer’s interests and avoiding conflicts of interest.

iv. Capital controls: The draft code suggested emphasizes focus on ac-countability and legal processes of capi-tal control and does not touch base on sequencing and timing which have been left open to be addressed by future pol-icy makers. The recommendation is to have a mixed formulation; wherein the rules governing the principal repayment should be set by Central Government in consultation with RBI and the outward capital flows should be governed by RBI in consultation with Central Government.

v. Systemic risk: Alternatively known as ‘Market risk’, addresses the possi-bility of failure of financial system as a whole, whereas micro-prudent regulation focuses on a single financial firm. It rec-ommends the empowerment of Finan-cial stability and Development Council (FsDC) as a statutory body. FsDC was established as an outcome of RBI Gov-ernor, Raghuram Rajan’s (2008) report. Crisis management would be the key to mitigate and deal with systemic risk.

vi. Development and redistribution: The Commission stresses on the point that the efforts of the regulators to en-sure financial inclusion and redistribution of financial services could be achieved through modernisation, best practices and increased consumer participation by enabling the Central Government to direct the regulators to ensure provi-sion of financial services to consumers.

vii. Monetary policy: Sustainable price stability is the goal of any monetary au-thority in a country. FsLRC recommends the creation of Monetary Policy Com-mittee (MPC) which would comprise of members from Central Government as well would work in collaboration with the Central Bank and enhance accountabil-ity. The other critical element in this sec-tion is the recommendation which would empower the Central Government to is-sue directives to the monetary author-ity in reserved cases, which may curb the independence of the Central Bank.

viii. Public debt management: Current-ly in India, a portion of the public debt is managed between the Central Govern-ment and Reserve Bank of India (RBI). The Commission proposes a specialized framework and formation of an indepen-dent public debt management agency to preside over the public debt market.

ix. Contracts, trading and market abuse: The final point in the Commis-sion’s report speaks about the enhance-ment procedures necessary for enabling the financial system. The Commission stresses on the greater clarity of the legal

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principals involved in the insurance indus-try. FsLRC also proposes multiple steps for the refinement of the security market. The point to be highlighted about the nine component focussed framework is that unlike the earlier laws which were sector specific, the Commission has taken special care to build a non-sector specific model. The non-sector specific based ap-proach caters to all the bodies of finance thereby creating synergies among differ-ent sectors especially when it comes to consumer protection. The committee has thus build a framework that could be used for decades to come without major modi-fications. However, building a clear and sound strategy for the nine areas only serves one aspect of the financial frame-work. The key to achieve success in the nine areas lies in the other aspect i.e. the financial regulators. FsLRC report comprehensively discusses the objectives, power and the accountability of the agencies associated with the financial framework of the nation. A striking fact that report highlights is that a financial regulator finds unique place in the liberal democratic nation as it is one of the few institutions to have been en-trusted with all the three responsibilities – legislative, executive and judicial, which in general requires separate bodies gov-erning them. The argument of indepen-dence would thus be more favourable only if strong accountability mechanisms are in place. The draft Code by the Commission hence ensures that each responsibility is defined with a measured specificity in the report.i. Legislative: The draft Code sug-

gested by the Commission stresses the importance of a structurally well-defined and drafted regulation mechanism to be adopted. The regulator would be first re-quired to articulate the objective, problem or the failure that the regulation seeks to address, followed by the cost-benefit analysis of the regulation. The whole ef-fort would take time and involve consider-able expenditure of the regulator but the end product would be a quality regulation with little space for unambiguity. The Commission keeps in mind the situations when there will be need for regulations on an urgent basis. For such scenarios regulation can be carried out without the basic steps but such regula-tions would be discontinued six months after the commencement. The Commis-sion also proposes the introduction of ju-dicial review of the regulations as a tool to check and balance the activities of the regulator.

ii. Executive: The draft Code identifies two elements – processing of permission and information gathering as a key to the executive functions of the regulator. The Commission proposes a single ‘Financial Data Management Centre’ wherein all the financial agencies would report their regular information which could then be available to all the regulators at the click of a button.

iii. Judicial: The Commission proposes a systematic approach & well defined stan-dardized categories for the penalties which would lead to greater consistency in the penalties for the offences and also help in mitigating the occurrences of the offences.

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The Commission also proposes a unified Tribunal ‘Financial Sector Appel-late Tribunal’ for the judicial review of the working and functioning of the regulators. FsLRC’s has emphasized a lot on the functions and powers of the FSAT to en-sure the smooth and efficient introduction of the judicial review process in the finan-cial system. The FSLRC report has arrived at the opportune time for the economy that is fighting its way out of the economic glut it has been in for few years. The sugges-tions made by the commission comes out after an extensive research and deep un-derstanding of the Indian financial sector and thus the complete overhaul dosage offered by the Commission fits in perfect-ly in the current era. The report has not been short of critique though especially from the regulators. one such example is of the RBI Governor, Dr. Raghuram Ra-jan, who raised a few objections recently in a convention. Though happy with the overall report, Rajan cited two areas of tension. one is the proposal for introduc-tion of the judicial review to check and bal-ance the activity of the regulator and sec-ond is the size and scope of the regulator. The former point would hurt the flexibility of the regulator according to the Governor thereby will act as a detriment to the effi-ciency. He strongly argues that the judicial review tribunal may lack the experience and knowledge which the regulators pos-sess in handling special situations. For the second area of tension, he argues that though at one end FsLRC emphasizes on bringing some regulators under one entity

but in the process it is breaking up other entities. According to him this would lead to loss instead of gain in synergies. The Governor simply answers, ‘If it ain’t broke, don’t fix it’. Governor’s remarks soon met with a retaliatory article by the chairper-son of the Commission, Justice (Retired) B.N. Srikrishna in Economic Times. The chairperson vehemently supported the suggestions made by the Committee and criticized the Governor for stone walling the reforms. Hopefully the war of words would end and implementation process would start with little modifications if need be. FsLRC is a huge step in the direc-tion of modernization of the Indian Finan-cial sector which has gone many para-digm shifts since independence. The Acts and Policies that are followed currently were enacted when the sector was in its infancy. The nation has come a long way and is finding its feet in the international arena. The sustainability of the strength of the nation depends majorly on the fi-nancial health of the country. FsLRC’s recommendations thus provides the right dosage to keep the financial sector run-ning efficiently for decades to come.

References

• http://articles.economictimes.indiatimes.com/2014-06-26/news/50884722_1_securities-appel-late-tribunal-judicial-review-raghuram-rajan• http://www.moneycontrol.com/news/econo-my/heresrajan-thinksthe-fslrc-report-_1105922.html• Report of the Financial sector Legislative Re-forms Commission - Volume I: Analysis and Recom-mendations, March 2013• Report of the Financial sector Legislative Re-forms Commission – Volume II: Draft Law, March 2013

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MAKInG sEnsE oF P/ERATIOPlotting P/Bv with RoE

authorchitrank Jain

We have learnt about the price to earnings ratio in our Financial Analysis class and based on it we have often

gotten into debates regarding the undervaluation or over-valuation of the subject companies with our colleagues. We are guided by our professors, textbooks etc. that one cannot look at the price to earnings ratio in isolation and reach to any particular conclusion from it. To address this limitation the model we are going to discuss here is going to use two inputs P/Bv and RoE.

Price to earnings ratio = Current market price / Earn-ings per share

EPs actually is return to the equity shareholders on the book value per share.

Return to equity shareholders = Book value (total net worth) * Return on Equity (ROE)

Using the above two equations the formula for price to earn-ings ratio can re-written as –

Price to earnings ratio = (Current Market price/ Book value per share)/Return on equity

P/E ratio has been dissected into these two compo-nents because analysis of these two factors historically has shown that the P/Bv multiple very closely tracks the chang-es in the returns on equity. ( Analysis shown in figure )

chitrank Jain is the stu-dent of S.P. Jain institute of management and research, mumbai. he is currently interning with macquarie capital Securi-ties india as an Equity research intern. Prior to mBa he was working with Kotak mahindra Bank for 2 years.

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I took the Price to book value ratio and return on equity (%) of 50 companies forming the NIFTY index and plotted these values on a scatter plot and then gener-ated the best fit line from the coordinates. With a little eye balling we can conclude that most of the coordinates lie close to the best fit line displaying that market is pricing most of the NIFTY 50 companies in line with their Return on Equity (%). Also we can see a strong R-square of 0.736. From the above, intuitively we can conclude that the coordinates lying above the best fit line show the stocks which are valued above what markets actually generally expect and vice versa for points lying below the best fit line. And higher the distance of coordinates from the best fit line higher will be the extent of over/under valuation.

Despite low RoE, market may value a particular stock at higher multiples as compared to the market in general because of reasons like high expected future growth and contrary to this higher RoE need not necessarily lead to a higher price to book value ratio because of risks associated with the business/company.

The above analysis can be done for different indices, sectors etc. depending on the requirement.

November 2014efiNaNcialcoNNect.com

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INVESTMENT IN GOLDETF

Ease, Safe & Secure and Tax Benefits

authordhawal dave

In current times, common investors are in dilemma

where to park their surplus fund as for them tracking a particular stock or index is very tough as it involves various technical & analysis tools. other traditional safe investment options are Fixed Deposit (FD) with Bank, Post office savings etc. Which gives very low rate of returns and FDs also attract tax li-ability at the time of redemp-tion. Question arises here is where to invest to earn better than traditional prod-ucts and that too with safety. our recommendation is that one should start investing in GOLD ETF. What is a Gold ETF? Is it equity? Index? Many such questions will be arising in your mind right now. To make it very simple, we can explain, Gold ETF as dematerialised / electronic form of physical gold. one unit of gold represents one gram of pure gold. Gold ETF

are traded on both exchang-es namely, BsE and nsE and it can be bought as you buy normal equity (stock) of any listed companies. You need not open any separate account to buy Gold ETF.

Ease of investing & sell-ing: one can buy / sell Gold ETF on a click of but-ton, sitting at his home/of-fice through desktop/laptop/mobile. one can also buy it through trading terminal of its registered sub-brokers (fran-chisee of a main member) or branch of any main member of both stock exchanges.

Safe and Secure: When you buy physi-cal gold, main worry is about its storage. Either you keep it in locker of a bank and pay rent and every time you buy go and put into it, or keep at home and keep worry-ing about theft. Gold ETF is

author of this article is having experience of 15+ years in financial sector and 9+ years directly in equity/commodity market. he is founder promoter of a leading broking house in Gujarat. he can be reached on dhawal-dave@sunflowerbroking.com for any queries related to financial invest-ment/planning.

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100% electronic version and fully secured from any kind of theft. You just buy it and relax no worry of going to banks or theft from your home storage.

Save on making charges of physical Gold When you buy gold jewellery, on an average, you pay 8-10% as making charg-es depending on jewellers / brand. Even when you go to sell it, making charges will be deducted once again and net amount will be paid to you. Therefore in total you are spending somewhere between 15-20% as making charges. Whereas in Gold ETF transaction charges are very less (0.25% maximum), transparent and uni-form across India as it is traded through common exchange platform.

How to maximise returns

To maximise returns through invest-ment in GOLD ETF, one should follow, systematic investment plan (commonly known as sIP). For example, investor

can fix that every month he/she will buy one gram of gold on advice of his broker/financial planner to buy at which rate. If investment is done in such manner, one can easily earn returns of 12-15% without any hassle.

Tax advantages:• Investment in Gold ETF is free from wealth tax.• Long term capital gain is 10% with-out indexation and 20% with indexation• There is no STT (Securities Trans-action Tax) on it our view is that one should opt for investment in Gold ETF as an option of investing in physical gold. We end this article with declara-tion that views expressed over here are of personal capacity of author and not of Sunflower Broking as a company. Invest-ments & returns in this instrument are subject to fluctuations in gold prices. one should take advice of his/her financial planner before making invest-ment in any financial instruments linked to the market.

November 2014efiNaNcialcoNNect.com

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CAPITAL FLOWS IN InDIA

Total capital flows into India through FDI, FII

route has averaged around USD 60 billion over the last few years before dipping to around USD 46 billion in fis-cal year 2013-14, largely on the back of fall in equity flows and on the back of negative flows into debt. FII equity flows dipped from USD 24 billion to USD 13 billion last fiscal as Fed taper sparked a sell off in emerging market assets. FII debt investments saw outflows of USD 4 billion last fiscal. FDI (Foreign Direct In-vestments) has been steady

at around USD 35 billion over the last few years except for a one off spurt in 2011-12.

Capital Flow expectations for FY14:

The first three months of fiscal 2014-15 has seen flows of USD 10 billion into equities and debt with FII eq-uity flows at USD 5.6 billion and debt flows at USD 4.5 billion. Going by this trend, FII debt and equity flows could cross USD 40 billion in fiscal 2014. FDI flows could also see an increase if the government opens up sec-tors such as defence and

authorSufiyan Sarguroh

Sufiyan Sarguroh is a Sec-ond Year m.m.S. (finance) student at Sydenham institute of management Studies. Sufiyan has a prior work experience of 2 years at larsen and toubro infotech ltd. Sufiyan is passionate about writing. and when not writing, he is busy playing football.

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November 2014efiNaNcialcoNNect.com

railways to FDI. FDI flows could well rise by around 30% in this fiscal to levels of USD 45 billion.

Total capital flows from FDI and FII investments could be in the range of USD 85 billion in the fiscal year, almost double of what was seen in 2013-14. Going into fiscal 2015-16, flows could well be main-tained at higher levels if the government steps to strengthen the Indian economy starts to work and RBI steps to bring down CPI to levels of 6% also work.

Reason for increased expected capital inflows:

The positives for increased capital flows into India are high global central bank liquidity, benign policy rates and lack of inflationary threats in developed economies. Central banks of the Fed, ECB, Bank of Japan (BOJ) and Peoples Bank of China have aggressively pushed up their balance sheet size by 2x to 4x over the last few years. The total liquidity infused by these four central banks is at

around USD 14 trillion and this liquidity is in the system in various forms.

Liquidity from Fed, ECB and BOJ traverses the globe given free float cur-rencies of these economies while China liquidity is internal. Liquidity is unlikely to dry up or be sucked out soon given that economic growth is weak and inflation is benign in these countries.

The Fed is on course to stop asset purchases by end of calendar year 2014 and could also start raising policy rates from record low. However the Fed will keep its balance sheet at higher levels and will not shrink it given that the US economy is not completely out of the woods despite good economic performance post the cri-sis in 2008.

The ECB will keep rates low into 2016 and will look to increase its balance sheet size to take the Eurozone economy into a growth path. BOJ will keep its mon-etary stimulus as Japan looks to get back into a growth zone.

What are capital flows? movement of money for investment and trade between countries is called capital flow. Movement into the country is called capital inflow, while movement out of the country is called capi-tal outflow.

Importance of Capital Flows: Capital flows are generally welcomed in most countries as they assist in the proper alloca-tion of global resources and thereby increase the availability of capital and thus higher investment

and growth. they are instrumental in the transfer of technology and management skills. Some of the other advantages of foreign investment are: risk sharing with the rest of the world, greater exter-nal market discipline on macroeconomic policy, broader access to export markets through foreign partners, training and broader exposure of nation-al staff, greater liquidity to meet domestic financ-ing needs, broadening and deepening of national capital markets, and improvement of financial sector skills.

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authorramya lakshminarayanan

E-Commerce in India is at an exciting stage in

current times. The sector has seen a slew of deals and launches in the recent past: Amazon marked its en-try into Indian shores with a high-decibel campaign, Flip-kart acquired Myntra in a deal pegged at Rs. 2000 Cr, Snapdeal raised $100 million in PE funding, BookMyshow entered into the Rs 1000 Cr valuation bracket. Walmart plans to launch its B2B e-commerce marketplace in July, and Narayana Murthy plans to enter e-commerce through a joint venture be-tween his firm Catamaran ventures and Amazon. The market size of In-dia’s e-commerce was es-timated to be around $13 billion in 2013, according to a joint report of KPMG and Internet and Mobile Associa-tion of India (IAMAI). CRI-sIL Research projects an aggressive growth of 50-55 percent CAGR till 2016 for

online retail.

Industry Structure: There are multiple ways in which the E-Commerce industry can be classified - based on business models, service(s) offered, participants of transaction (B2B/B2C/C2C) etc. In terms of service offering, the industry can be broadly classified into - online ticketing, online retail, online marketplaces and online deals. In addition, there are some additional types of offerings such as education, which do not strictly fall under the aforementioned categories.

Growth Drivers: From shopping for electronics, groceries etc., to buying tickets, ordering food, booking travel packages or even using classifieds: e-commerce covers it all. Increasing internet

ramya is a final year mmS student of SimSrEE, an aspiring finance profes-sional, an avid reader and a compulsive night owl. She has written in the past for multiple fora like her college blog, alumni newsletters, and newspa-per articles.

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E-CoMMERCE InInDIA

Trends and Outlook

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penetration in India has seen a steady growth in the last few years, but is still very low (~19%) compared to global av-erage of 40%. Concurrent with the growth in internet penetration is the growth in online transactions. An industry estimate by Avendus says that the number of on-line transactions will reach 38 million in 2015. E-commerce players have identified the importance of customer-centricity and compete fiercely on parameters such as price, speedy delivery, express delivery service etc. The growth in e-commerce is not just because of the marked shift in

consumer preferences, but also because sellers have gone a step ahead and made certain products available for purchase only through online channels.

Profitability: Although the sector has seen unprecedented growth, and vCs and PE funds have significant stakes in most e-commerce players in India, the players have yet to turn profitable. This is especially true in case of e-retailers. Players like Flipkart are focused only on capturing market shares across categories, rather than immediate profitability.

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Investors (mainly PE funds) have bet high on valuations of these e-com-merce companies soaring once they turn profitable, and/or eventually go public, like in the case of Just Dial.

The Way Ahead:

The barriers to entry in this sector are low. With more and more organized retailers going online to reach a wider audience, e-commerce is set to see very

promising growth – both organic (new players entering the field) and inorganic (existing players establishing online pres-ence).

There is a need to set up an appro-priate legal framework to ensure smooth sailing for industry. If this concern is ad-dressed by the new government, and with reports that FDI in e-commerce is likely to be allowed in India soon, it would pave the way for next wave in Indian business.

November 2014efiNaNcialcoNNect.com

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TIEI can give students an edge in job market and in personal investments

What is TIEI? (A brief introduction about institute and the courses) Trading and Investment Educational Institute is a practical based educational institute that specializes in stocks, futures, option and forex market. We are global-ized institute where our clients come from all walks of life around the world to attend our online classes without geographical or educational restriction.

What are your plans in India? TIEI’s vision is to create well informed investors to make educated decisions in their investment whether trading them-selves or through their brokers. The course is designed in a way to make the students understand the subject in a sim-ple less intimidating way without overbur-dening them with extra information. our goal is to create smart investors and trad-ers at the very grass root level to enable for strong careers, strong companies and eventually a stronger economy. How do you see TIEI courses adding value to Indian B-schools? TIEI’s practical based education can add tremendous value to B school by bridging the gap between B school and financial companies as TIEI education will en-able them to apply the knowledge to their advantage in their careers and for better

positions compared to counterparts. TIEI can give students an edge in job market and in personal investments.

How do you see Indian financial markets? The Indian markets has tremen-dous growth over the next few years as volatility is increasing as more people are confident about the markets. This will create more different instruments to be traded which will require a variety of strat-egies that need to be learned for maxi-mum growth in these times. It is no lon-ger the case where one can buy a stock and leave it for a few years as too much short term volatility and other events can dictate stock prices. one should learn how to trade short and long term to ben-efit from the market scenario presented in the current times.

”“An Interview with Lakshmi Gangatkar

Administrative Director, TIEI

November 2014efiNaNcialcoNNect.com

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